Speech
Some Implications of the Internationalisation of the Renminbi

I would like to thank the Centre for International Finance and Regulation (CIFR)
for the opportunity to open today's conference on the internationalisation
of the renminbi. This topic is an extremely important one and the Reserve Bank
is a strong supporter of CIFR's work in this area.

In my own view, the internationalisation of the renminbi (RMB) – and the changes
that accompany it – could ultimately prove to be as transformative for
global capital markets as was the earlier opening up of China's borders
for the global trading system. Even if this turns out to be only half correct,
then we need to better understand the process of internationalisation of the
RMB, including the pitfalls and the opportunities. This conference is another
important step in that journey of understanding.

Internationalisation of the RMB and Capital Flows

At the outset, I think it is useful to be precise about what we mean when we talk
about ‘internationalisation’. In my view, for a country's currency
to be viewed as internationalised there are two key conditions that need to
be met.

The first is that the country's currency is used for transactions between its
residents and non-residents. The progress that China is making in this area
is significant, particularly on the trade side. Over the past few years, the
share of China's international trade that is denominated in RMB has risen
significantly and this trend is expected to continue. On the investment side,
there has been an expansion in the schemes that permit approved foreign residents
to invest RMB in China. Indeed, over recent times a number of central banks
(including the Reserve Bank) have invested some of their foreign currency reserves
in RMB. The market for offshore RMB-denominated bonds has also grown strongly,
with Chinese residents accounting for the majority of issuance. Further, plans
have been announced to allow Chinese residents to invest RMB in approved offshore
destinations.

The second condition is that the currency is used in transactions between non-residents.
In particular, a truly internationalised currency is one where:

non-residents are willing to raise funds in that currency despite ultimately being
in need of another currency; and

there are non-residents who are willing to hold an unhedged exposure to that currency.

China has made some progress in this area, but, to date, that progress remains relatively
limited. There have, for example, been some reports of non-residents issuing
RMB-denominated bonds in the offshore market and swapping the proceeds into
their home currencies. But in general, there is still a fair way to go here,
including in the development of markets that would support the use of the RMB
in this way.

Ultimately, further progress in internationalising the RMB is inextricably linked
to China's transition towards capital account liberalisation and a more
flexible exchange rate. Experience elsewhere around the world, including here
in Australia, suggests that extensive exchange controls and a highly managed
exchange rate are unlikely to be consistent with an internationalised currency.

The Chinese authorities understand this and have signalled their intention to further
liberalise the capital account and move to a more flexible exchange rate. We
saw the latest step in this transition just last week when the daily trading
range for the RMB against the US dollar was widened from ±1 per cent
to ±2 per cent.

While the journey is clearly a gradual one, I suspect that over the years ahead,
the further liberalisation of the Chinese capital account could turn out to
be one of the really significant events in global capital markets. To date,
much of the capital outflow from China has been intermediated – indirectly
– by the People's Bank of China through its intervention in the foreign
exchange market and its accumulation of over $US3½ trillion of
foreign reserves. At some point, as controls on capital outflows are lifted,
this model is likely to change. As it does, the non-official sector will become
increasingly responsible for managing the foreign assets of Chinese residents.

As CIFR's report notes, this transition is likely to be associated with an increase
in outflows of private capital.[1]
This is likely to lead to a change in the type of foreign assets that Chinese
entities hold and could have significant implications for some of the asset
markets in the countries that receive these inflows. The increase in private
capital outflows is also likely to lead to an increase in demand for hedging
products by Chinese entities, as at least some of these entities will want
to hedge their currency and other risks on their new offshore investments.
This growing demand can be expected to support the development of foreign exchange
markets in China.

The ability to hedge foreign exchange risk is – alongside the ability to denominate
foreign liabilities in local currency – an important ingredient in helping
ensure that the benefits associated with a more open capital account and flexible
exchange rate are not outweighed by potential financial (in)stability costs.

Indeed, the development of deep and liquid hedging markets is one of the reasons
why Australia's experience with capital account liberalisation and exchange
rate flexibility has worked out well. When we first moved from a fixed, to
a managed, to a floating exchange rate regime in the 1970s and 1980s, these
markets were not particularly well developed, but they have since matured significantly.
In large part, this occurred organically in response to the increase in demand
for hedging products that arose once the exchange rate became more variable.
This may well be the case for China too.

This positive feedback loop between liberalisation and market development is also
an important lesson from our own experience: if liberalisation does not occur
it is hard for markets to develop, and if markets are not developed it is hard
to liberalise. But a gradual process of liberalisation can promote market development
and stability which makes it easier to liberalise further.

One element of this positive feedback loop is that greater use of RMB for trade invoicing
by Chinese firms can allow these firms to reduce currency mismatches on their
balance sheets and thus alleviate potential vulnerabilities that could otherwise
arise from a more flexible exchange rate regime. Another is that, as capital
account liberalisation proceeds, the entry of non-residents to China's
domestic financial markets will increase the depth of these markets. And as
non-residents become more willing to take on RMB exposures, the pool of potential
counterparties for Chinese entities seeking to hedge their foreign currency
liabilities will also increase.

Nobody knows precisely how this whole process of RMB internalisation will play out.
This is partly because there is no historical precedent for an economy of China's
size and relative stage of development integrating itself into a global financial
system that is as complex and interconnected as we see today. There are, as
Professor Eichengreen highlights in his paper, an array of challenges, risks
and uncertainties inherent to China's transition to an open, more market-based
economy.

In some ways the task for China is more difficult than it has been for other countries
that have made this same journey, including Australia. First, there is much
more international scrutiny and the rest of the world has a very strong interest
in the outcome. And second, China's financial sector is already very large
relative to GDP meaning that setbacks in the reform process could have significant
effects on the broader Chinese economy.

That said, if Australia's experience is any guide, the journey can turn out to
be a positive one. For us, financial reform and the integration of our capital
markets into the global system delivered the basis for sounder macroeconomic
policy, more diversified portfolios for Australian investors and the development
of tools for hedging risks. But the journey was not without its troubles and
there was much learning by doing along the way. At the beginning, the risk
management skills of the Australian banks were inadequate to cope with a world
in which there was much freer access to foreign capital and credit was no longer
rationed. Regulators were also ill-equipped to provide effective supervision.
The combination of these institutional weaknesses and intense competition among
banks manifested itself most prominently in a bubble, and eventual bust, in
commercial property prices in the late 1980s.

Today, China is going through its own adjustment pains. But we should not forget
that internationalisation of the RMB holds out the promise of the same benefits
that internationalisation of the Australian dollar has delivered for us here
in Australia. The effects will not only be felt in China itself, but throughout
the world. Amongst other things, the opening up of China's capital account
and the process of RMB internationalisation may well elevate the RMB to international
reserve currency status. While this still looks to be some way off, it would
represent a profound change in the nature of the international monetary and
financial system. Some of the potential impacts of all of this are explored
for us in Prasanna Gai's paper for this conference.

Some Implications for Australia

I would now like to briefly touch on some of the implications of RMB internationalisation
for us here in Australia.

It is perhaps stating the obvious to say that we have a strong interest in China's
financial reform journey being a successful one. Financial reform can play
a significant role in promoting economic and financial stability in our major
trading partner. Furthermore, over time, a change in the structure of Chinese
capital flows could have significant implications for our own capital and asset
markets. And, an increased demand for hedging products and other financial
instruments could open up new opportunities for our financial institutions.

In the immediate future, Australia's already strong trade links with China and
the growing financial linkages between our two countries mean that there are
mutually beneficial opportunities from RMB internationalisation.[2]
Some of these are explored in CIFR's research report, and will be discussed
by Geoff Weir later today. For example, Australia's funds management industry
can benefit from increased investment opportunities within China as inward
capital flows to China increase. It can also benefit from sharing its expertise
with Chinese funds managers and/or providing direct funds management services
to Chinese investors as private outward capital flows from China increase.
Similarly, the use of RMB for trade settlement in commodity markets may also
be mutually advantageous.

In this context, the results of the survey that CIFR has conducted of Australian
and Chinese firms' attitudes towards the use of RMB as a trade invoicing
currency are particularly relevant. The CIFR survey is an extended version
of an earlier RBA survey of Australian firms that was conducted, with the help
of local banks, in the lead-up to the inaugural Australia-Hong Kong Renminbi
Trade and Investment Dialogue held in Sydney in April last year.[3]

The more recent survey – which Kathy Walsh will present later today –
highlights the fact that many Chinese firms still are not aware that RMB can
be used as a trade settlement currency. More positively, some of the impediments
to RMB trade settlement that were evident in the RBA's initial survey in
2013 – in particular, those related to administrative burden and payment
delays – appear to have recently lessened somewhat.

With the second Australia-Hong Kong Renminbi Trade and Investment Dialogue coming
up in May, the survey results highlight the importance of efforts to educate
firms in both Australia and China about both the RMB trade settlement process
and the RMB banking and hedging products that are already available. In this
regard, I welcome the Australian financial sector's efforts to support
the development of an RMB market here in Sydney, in particular, by ensuring
that the current and future RMB product needs of Australian corporates are
met, and that clients have ready access to information. Another encouraging
sign is the recent announcements by two Chinese banks operating here in Sydney
regarding RMB clearing services.

Conclusion

The internationalisation of the RMB – and China's associated move towards
a liberalised capital account and more flexible exchange rate regime –
has the potential to create a seismic shift in the international monetary and
financial landscape. And while China clearly has an interest in getting this
process right, the rest of the world – including Australia – also
has a strong interest in the outcome. History teaches us that financial deregulation
is an inherently risky process, but that there are substantial payoffs if it
is done well. Conferences like this are an important part of understanding
this whole process and I wish you all the best in exploring the challenges
and opportunities that lie ahead.

Endnotes

I would like to thank Michelle Wright for assistance in the preparation of these
remarks.
[*]

Centre for International Finance and Regulation (2014), ‘Internationalisation
of the Renminbi: Pathways, Implications and Opportunities’, Research
Report, March. Available at <http://www.cifr.edu.au/site/Research/Targeted_Research_RMB_Internationalisation.aspx>.
[1]

I have previously discussed some aspects of this deepening financial relationship
in Lowe P (2013), ‘The Journey of Financial Reform’, Address
to the Australian Chamber of Commerce in Shanghai, Shanghai, 24 April.
[2]